Trusts are often misunderstood. Many people think they are complicated, inflexible and the preserve of only the very wealthy. However, the truth is that they can be a highly effective way of reducing a potential tax liability and increasing the efficiency and flexibility of your assets. In addition, they are essential in ensuring that your assets go to whom you want, when you want - even after you have passed away.

If you do not know whether you may have a tax liability or require a trust, click here to be sent a IHT & Trust Calculator

What is a trust?
The term ‘trust’ refers to the legal relationship created, during an individual’s lifetime or on death.

A trust is created when a person (the settlor) provides the capital which is then placed outside of his or her legal control and administered by another (the trustee) for the benefit of another person (the beneficiary) or for a specified purpose

.

When a trust is set up, it means:

(a) legal ownership of the trust assets stands in the name of the trustee
(b) the assets within the trust are no longer part of the settlor’s personal assets
(c) the trustee is accountable for managing, employing or disposing of the trust assets in
    accordance with the terms of the trust (laid down by the settlor).

Why use a trust?
One of the main reasons for using a trust is to save tax, mainly (but not exclusively) inheritance tax. Of course there is much more to trusts than simply reducing your tax bill.

With careful planning you can ensure that, even after your death, your loved ones are still able to benefit from your wealth in the way that you would have wanted.

Certain trusts also allow you to retain a significant degree of control over any assets that you give away. Therefore, you can give away your assets without losing absolute control. They can allow you to pass on your assets whilst you are still alive.

Trusts can also be used to pass assets to those that are currently or permanently incapable of administering them, a young child for example.

Reducing your tax bill?
Add up the value of your savings and investments, your home and its contents. Will your estate have an inheritance tax bill?

In times gone by inheritance tax was an issue for the very wealthy in UK society. In recent years, inheritance tax has become a concern that more and more families have become acutely aware of.

For inheritance tax purposes, your estate is basically the value of your net assets at death. Your inheritance tax liability is calculated on the total of:

(a) the value of your estate
(b) gifts made in the 7 years before death
(c) gifts made at any time from which you continue to benefit.

From this total you can deduct various exemptions and relief’s. The remainder is subject to tax at two rates:

£0 - £285,000 = 0%
In excess of £285,000 = 40%

The first £285,000 is known as the ‘nil rate band’ and is generally increased annually.

If your calculations show that you have an inheritance tax liability, then you need to consider plans to reduce this potential. Failure to do so will benefit the Inland Revenue rather than your family!

You may think that a simple solution would be to give away some assets and thus reduce the value of your estate. However, there are a number of difficulties with this strategy.

Many gifts are still potentially taxable for the next seven years. Additionally, once you have made a gift you have no control over the gifted assets.

You will lose access to and the use of the gifted assets. You will lose the income generated from the gifted assets. If you continue to benefit from the gifted assets they will still count as yours for inheritance tax purposes.

The Government long ago realised that it was possible to escape tax by giving away assets shortly before death. Planning such as this has been countered by the potentially exempt transfer rules. A gifted asset remains taxable for seven years from the date of gift. What is more, the person making the gift must not enjoy any benefit from that gift during the seven year period – or afterwards.

Once seven years have passed the gift is inheritance tax exempt. If you do not survive for a full 7 years after the gift and the gift (or cumulative gifts) exceeds the nil rate band, the tax attaching to that gift may be reduced. This is called taper relief. It should be noted that there is no relief if you fail to survive at least three years.

Transfers between spouses are generally exempt and therefore fall outside the potentially exempt transfer rules. It is important to realise that full exemption loses the benefit of the nil rate band.

The term ‘spouses’ means married couples so unmarried partners cannot benefit from this exemption and will have to adopt other tax planning strategies.

Other exemptions
Every year you are allowed to make a gift of £3,000 and this will immediately fall out of your estate for inheritance tax purposes. There are also generous exemptions on the occasion of marriage. In addition there are other exemptions relating to small gifts or regular gifts of income.

Whilst these exemptions can seem of little value they can add up to significant savings over time and therefore should be considered as part of an estate planning strategy

However whether you are making your gift though a potentially exempt transfer, through small regular gifts or a combination of both you need to consider that once you have gifted your assets you will no longer have any control over it.

This is where trusts can also become extremely useful - through them you can still exert a degree of control over the money you have gifted away.

The objective of inheritance tax planning is to pass on wealth to succeeding generations through effective tax gifts. However, no matter who you are, no matter how large or small your family, many would naturally be concerned that once we have gifted some of our estate away we would no longer have any control over the gifted assets.

Remember that you have seven years to wait until your gift fully falls outside of your estate, and in seven years a lot can change in your and your family’s world.

For example, say you gifted some money for your child to pay for the increasingly onerous expense of a university education. But once you had gifted the child that money what could you do if they used that money in a way you did not approve.

Trusts can be looked on as ‘gifts with strings’ because the settlor can set such terms and conditions on the gifts as she or he sees fit.

Trusts can also be looked upon as ‘deferred gifts’ because there will be a delay – an intentional delay – between the settler gifting the assets and the beneficiary gaining full use of them.

When you set up the trust you appoint trustees to administer the trust on your behalf. You can be a trustee yourself. It is usual to have more than one person other than yourself acting as trustee.

As trustees you will invest the trust assets (your gift) for the benefit of the beneficiaries. The beneficiaries are the people, or group of people (say, your children) to whom the trustees can pay benefits.

Therefore, in our example above, instead of paying the money directly to your children you can pay it into a trust that you have set up for them. The trustees will then look after the money and pass it through to your children as and when they need it for their education (for example, as university fees arise). So, using a trust you can gift away your assets and create a potentially exempt transfer and still retain a significant degree of control over your assets.

Candour Consultancy offers a range of draft trusts which assist with inheritance tax planning strategies. Each trust has a different set of features which, when used with a life assurance product, can assist with your inheritance tax planning.

Choosing the right trust is essential and specialist professional advice should be taken to ensure that a particular draft trust meets your requirements. However, if you do not know whether you may have a tax liability or require a trust, click here to be sent an IHT & Trust Calculator that will inform you of any liability. Candour Consultancy can then advise on a suitable course of action.